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Section 1: 8-K (8-K)

Document
 


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
  
 
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 OR 15(d) of The Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): August 7, 2018
 
  
 
REDWOOD TRUST, INC.
(Exact name of registrant as specified in its charter)
 
 
 
 
 
 
Maryland
 
001-13759
 
68-0329422
(State or other jurisdiction
of incorporation)
 
(Commission
File Number)
 
(I.R.S. Employer
Identification No.)
One Belvedere Place
Suite 300
Mill Valley, California 94941
(Address of principal executive offices and Zip Code)
(415) 389-7373
(Registrant’s telephone number, including area code)
Not Applicable
(Former name or former address, if changed since last report)
 
  
 
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):
o
Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)
o
Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)
o
Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))
o
Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 or Rule 12b-2 of the Securities Exchange Act of 1934.
Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o





Item 2.02.
Results of Operations and Financial Condition;
 
Item 7.01.
Regulation FD Disclosure.
On August 7, 2018, Redwood Trust, Inc. issued a press release announcing its financial results for the quarter ended June 30, 2018 and The Redwood Review - 2nd Quarter 2018, copies of which are attached as Exhibit 99.1 and Exhibit 99.2, respectively, to this Current Report on Form 8-K.
On August 7, 2018, Redwood Trust, Inc. issued a press release announcing its Board of Directors’ authorization to declare a third quarter regular dividend of $0.30 per share, a copy of which is attached as Exhibit 99.3 to this current report on Form 8-K. The third quarter 2018 dividend is payable on September 28, 2018 to stockholders of record on September 14, 2018.
The information contained in this Item 2.02 and Item 7.01 and the attached Exhibits 99.1, 99.2 and 99.3 is furnished to and not filed with the Securities and Exchange Commission, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except as shall be expressly set forth by specific reference in such filing.
 
Item 9.01.
Financial Statements and Exhibits.
(d)
 
Exhibits
 
 
Exhibit 99.1
 
Press Release dated August 7, 2018
Exhibit 99.2
 
The Redwood Review – 2nd Quarter 2018
Exhibit 99.3
 
Press Release dated August 7, 2018




SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
 
 
Date: August 7, 2018
 
 
REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
By:
 
 /s/ Collin L. Cochrane
 
 
 
 
 
 
 
 
 
 
 
Collin L. Cochrane
 
 
 
 
 
Chief Financial Officer






Exhibit Index
 
 
 
 
 
Exhibit No.
 
Exhibit Title
 
 
 
 
 
Exhibit 99.1
 
 
Exhibit 99.2
 
 
Exhibit 99.3
 
 
 
 
 
 


(Back To Top)

Section 2: EX-99.1 (EXHIBIT 99.1)

Exhibit

Exhibit 99.1

394548438_q218prlogoa01.jpg

    
FOR IMMEDIATE RELEASE
 
CONTACT:
Kristin Brown
Redwood Trust, Inc.
 
 
Investor Relations
Tuesday, August 7, 2018
 
 
(415) 384-3805
 
 
 
 

REDWOOD TRUST REPORTS SECOND QUARTER 2018 RESULTS

MILL VALLEY, CA Tuesday, August 7, 2018 – Redwood Trust, Inc. (NYSE:RWT) today reported its results for the second quarter of 2018.
Quarterly Financial Highlights
GAAP net income was $33 million, or $0.38 per diluted common share
Non-GAAP core earnings(1) were $36 million, or $0.41 per diluted common share
Book value per common share increased to $16.23 from $16.12 at March 31, 2018
Economic return(2) of 2.5% for the second quarter
Recourse debt-to-equity leverage ratio(3) of 3.4x

Business Highlights
Deployed $186 million of capital in the second quarter of 2018 toward new investments, including $50 million into new initiatives
Issued $200 million of six-year convertible debt at a rate of 5.625%
Closed four securitizations of $1.7 billion of loans in aggregate, including our fourth expanded-prime Choice transaction since the program’s inception
Declared our 76th consecutive quarterly dividend of $0.30 per share, an increase of 7% from the prior quarter
Raised $117 million of equity capital in July, our first follow-on offering since 2009
A further discussion of Redwood's business, financial results, core earnings and taxable income, as well as a discussion of management's 2018 outlook, is included in the second quarter Redwood Review, which is available on the Company’s website at www.redwoodtrust.com.
(1)
A reconciliation of GAAP net income to non-GAAP core earnings and a reconciliation of GAAP earnings per diluted share to non-GAAP core earnings per diluted share, along with additional information about Redwood’s core earnings measure, is included in the tables that follow.
(2)
Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.
(3)
Recourse debt excludes $1.9 billion of consolidated debt (ABS issued) that is non-recourse to Redwood.

1



Financial Performance
 
Three Months Ended
($ in millions, except per share data)
 
June 30, 2018
 
March 31, 2018
 
June 30, 2017
 
 
 
 
 
 
 
GAAP net income
 
$
33

 
$
47

 
$
36

GAAP net income per diluted common share
 
$
0.38

 
$
0.50

 
$
0.43

Non-GAAP core earnings
 
$
36

 
$
58

 
$
29

Non-GAAP core earnings per diluted common share
 
$
0.41

 
$
0.60

 
$
0.35

REIT taxable income (estimated)
 
$
27

 
$
33

 
$
19

REIT taxable income per share (estimated)
 
$
0.35

 
$
0.44

 
$
0.25

GAAP book value per share
 
$
16.23

 
$
16.12

 
$
15.29

Dividend per common share
 
$
0.30

 
$
0.28

 
$
0.28

Economic return
 
2.5
%
 
3.6
%
 
2.9
%
Recourse debt-to-equity leverage ratio
 
3.4x

 
3.4x

 
3.1x

Conference Call
Redwood will host an earnings call today, August 7, 2018, at 2:00 p.m. Pacific Time / 5:00 p.m. Eastern Time to discuss its second quarter 2018 financial results. The number to dial in order to listen to the conference call is 1-800-239-9838 in the U.S. and Canada. International callers must dial 1-323-794-2551. Callers should reference call ID #7178555. A replay of the call will be available through midnight on August 21, 2018, and can be accessed by dialing 1-844-512-2921 in the U.S. and Canada or 1-412-317-6671 internationally and entering access code #7178555.
The live conference call will also be webcast in listen-only mode in the Newsroom section of Redwood’s website under "Events." An audio replay of the call will also be available on Redwood's website following the call. Redwood plans to file its Quarterly Report on Form 10-Q with the Securities and Exchange Commission by Thursday, August 9, 2018, and also make it available on Redwood’s website.
Cautionary Statement:  This press release and the related conference call contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, including statements related to estimates of 2018 REIT taxable income and the expected timing for the filing of Redwood's Quarterly Report on Form 10-Q. Forward-looking statements involve numerous risks and uncertainties. Redwood's actual results may differ from Redwood's beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan” and similar expressions or their negative forms, or by references to strategy, plans, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected may be described from time to time in reports we file with the Securities and Exchange Commission, including reports on Forms 10-Q and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

2



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Income Statements (1)
 
Second
 
First
 
Fourth
 
Third
 
Second
($ in millions, except share and per share data)
 
Quarter
 
Quarter
 
Quarter
 
Quarter
 
Quarter
 
 
2018
 
2018
 
2017
 
2017
 
2017
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
83

 
$
77

 
$
71

 
$
63

 
$
59

Interest expense
 
(48
)
 
(42
)
 
(36
)
 
(27
)
 
(24
)
Net interest income
 
35

 
35

 
35

 
35

 
35

Non-interest income
 
 
 
 
 
 
 
 
 
 
Mortgage banking activities, net
 
11

 
27

 
3

 
21

 
12

Investment fair value changes, net
 
1

 
2

 

 

 
8

Other income, net
 
3

 
2

 
3

 
3

 
4

Realized gains, net
 
5

 
9

 
5

 
2

 
1

Total non-interest income, net
 
20

 
40

 
11

 
26

 
25

Operating expenses
 
(19
)
 
(23
)
 
(20
)
 
(20
)
 
(19
)
(Provision for) benefit from income taxes
 
(3
)
 
(5
)
 
5

 
(5
)
 
(5
)
Net income
 
$
33

 
$
47

 
$
31

 
$
36

 
$
36

 
 
 
 
 
 
 
 
 
 
 
Weighted average diluted shares (thousands) (2)
 
100,432

 
108,195

 
109,621

 
102,703

 
97,494

Diluted earnings per common share
 
$
0.38

 
$
0.50

 
$
0.35

 
$
0.41

 
$
0.43

Regular dividends declared per common share
 
$
0.30

 
$
0.28

 
$
0.28

 
$
0.28

 
$
0.28

 
 
 
 
 
 
 
 
 
 
 
(1)
Certain totals may not foot due to rounding.
(2)
In the periods presented above, weighted average diluted shares included shares from the assumed conversion of our convertible and/or exchangeable debt in accordance with GAAP diluted EPS provisions. Actual shares outstanding at June 30, 2018, March 31, 2018, December 31, 2017, September 30, 2017, and June 30, 2017 were 75,743, 75,703, 76,600, 77,123, and 77,117, respectively.






3



 
 
 
 
 
REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
Consolidated Income Statements (1)
 
Six Months Ended June 30,
($ in millions, except share and per share data)
 
2018
 
2017
 
 
 
 
 
Interest income
 
$
160

 
$
114

Interest expense
 
(90
)
 
(45
)
Net interest income
 
70

 
69

Non-interest income
 
 
 
 
Mortgage banking activities, net
 
37

 
30

Investment fair value changes, net
 
2

 
10

Other income, net
 
5

 
7

Realized gains, net
 
14

 
7

Total non-interest income
 
59

 
53

Operating expenses
 
(42
)
 
(37
)
Provision for income taxes
 
(7
)
 
(11
)
Net income
 
$
80

 
$
73

 
 
 
 
 
Weighted average diluted shares (thousands)
 
104,291

 
97,719

Diluted earnings per common share
 
$
0.88

 
$
0.85

Regular dividends declared per common share
 
$
0.58

 
$
0.56

 
 
 
 
 
(1)
Certain totals may not foot due to rounding.





4



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reconciliation of GAAP Net Income to Non-GAAP Core Earnings (1) (2)
 
Three Months Ended
($ in millions, except per share data)
 
June 30, 2018
 
March 31, 2018
 
June 30, 2017
 
 
 
 
 
 
 
GAAP net income
 
$
33

 
$
47

 
$
36

Adjustments:
 
 
 
 
 
 
Eliminate mark-to-market changes on long-term investments and associated derivatives (3)
 
(3
)
 
(7
)
 
(14
)
Include cumulative gain (loss) on long-term investments sold, net (4)
 
7

 
18

 
4

Income taxes associated with core earnings adjustments (5)
 

 

 
2

Total adjustments
 
4

 
11

 
(8
)
Non-GAAP core earnings
 
$
36

 
$
58

 
$
29

 
 
 
 
 
 
 
GAAP net income per diluted common share
 
$
0.38

 
$
0.50

 
$
0.43

Non-GAAP core earnings per diluted common share (6)
 
$
0.41

 
$
0.60

 
$
0.35

 
 
 
 
 
 
 
(1)
Certain totals may not foot due to rounding.
(2)
Core earnings is a non-GAAP measure of Redwood’s earnings and results of operations. Specifically, management has defined core earnings as: GAAP net income adjusted to (i) eliminate the impact of quarterly mark-to-market changes on the fair value of long-term investments (and associated derivatives) related to changes in benchmark interest rates and credit spreads, (ii) include the cumulative net gains or losses on long-term investments accounted for as trading securities under GAAP that were sold during the period presented, net of any gains or losses from derivatives associated with the investments sold, and (iii) include the hypothetical income taxes associated with core earnings adjustments.
Management utilizes this core earnings measure internally as one way of analyzing Redwood’s performance over multiple periods, as it believes it provides useful comparative results absent the impact of certain quarterly mark-to-market changes and other items that management believes are not reflective of core results. Core earnings should not be utilized in isolation, nor should it be considered as an alternative to GAAP net income or other measurements of results of operations computed in accordance with GAAP. A further discussion of core earnings is included in the second quarter Redwood Review.
(3)
Adjustments eliminate the mark-to-market changes on the fair value of loans held-for-investment, trading securities, other investments, and associated derivatives that are primarily related to changes in benchmark interest rates and credit spreads. Details on the components of investment fair value changes, net, are included in the Appendix of the second quarter Redwood Review.
(4)
Adjustment includes the cumulative net gains or losses on long-term investments accounted for as trading securities under GAAP that were sold during the period presented, net of any realized gains or losses from derivatives associated with the investments sold. Cumulative gains and losses are calculated by multiplying the difference between the sales price and original purchase price by the face value of the securities sold.
(5)
We apply estimated effective tax rates to core earnings adjustments occurring within Redwood's taxable REIT subsidiaries to estimate the hypothetical income tax expense or benefit associated with those adjustments.
(6)
Consistent with the calculation of net income per diluted common share for GAAP purposes, non-GAAP core earnings per diluted common share is calculated following the "two-class" method. Additional information on the calculation of core earnings using the "two-class" method can be found in Table 2 in the Financial Tables section of the second quarter Redwood Review.




5



REDWOOD TRUST, INC.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheets (1)
 
30-Jun
 
31-Mar
 
31-Dec
 
30-Sep
 
30-Jun
 
($ in millions, except share and per share data)
 
2018
 
2018
 
2017
 
2017
 
2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Residential loans
 
$
5,491

 
$
5,146

 
$
5,115

 
$
4,185

 
$
3,905

 
Real estate securities
 
1,454

 
1,358

 
1,477

 
1,356

 
1,219

 
Cash and cash equivalents
 
185

 
179

 
145

 
258

 
217

 
Other assets
 
383

 
318

 
304

 
332

 
315

 
Total assets
 
$
7,513

 
$
7,000

 
$
7,040

 
$
6,131

 
$
5,655

 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
$
1,426

 
$
1,504

 
$
1,939

 
$
1,238

 
$
1,295

 
Other liabilities
 
157

 
157

 
149

 
166

 
152

 
Asset-backed securities issued
 
1,930

 
1,542

 
1,165

 
944

 
693

 
Long-term debt, net
 
2,770

 
2,576

 
2,575

 
2,574

 
2,336

 
Total liabilities
 
6,284

 
5,780

 
5,828

 
4,922

 
4,476

 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
1,229

 
1,220

 
1,212

 
1,209

 
1,179

 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and equity
 
$
7,513

 
$
7,000

 
$
7,040

 
$
6,131

 
$
5,655

 
 
 
 
 
 
 
 
 
 
 
 
 
Shares outstanding at period end (thousands)
 
75,743

 
75,703

 
76,600

 
77,123

 
77,117

 
GAAP book value per share
 
$
16.23

 
$
16.12

 
$
15.83

 
$
15.67

 
$
15.29

 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
Certain totals may not foot due to rounding.


6
(Back To Top)

Section 3: EX-99.2 (EXHIBIT 99.2)

Exhibit

Exhibit 99.2

394548438_q22018redwoodoutsidefrontcov.jpg


 
  T A B L E O F C O N T E N T S


Introduction
 
 
Shareholder Letter
 
 
Quarterly Overview
 
 
Ñ Second Quarter Highlights
 
 
Ñ GAAP Net Income and Reconciliation to Non-GAAP Core Earnings
 
 
Ñ Analysis of Earnings
 
 
Ñ Segment Results
 
 
Ñ GAAP Book Value
 
 
Ñ Capital Allocations
 
 
Ñ 2018 Financial Outlook
 
 
Financial Insights
 
 
Ñ Balance Sheet Analysis
 
 
Financial Tables
 
 
Appendix
 
 
Ñ Dividend Policy
 
 
Ñ Core Earnings Definition
 
 
Ñ Forward-Looking Statements


 
THE REDWOOD REVIEW I 2ND QUARTER 2018
1

 
C A U T I O N A R Y S T A T E M E N T

This Redwood Review contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Our actual results may differ from our expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “anticipate,” “estimate,” “will,” “should,” “expect,” “believe,” “intend,” “seek,” “plan,” and similar expressions or their negative forms, or by references to strategy, plans, goals, or intentions. These forward-looking statements are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K under the caption “Risk Factors.” Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected are described below and may be described from time to time in reports we file with the Securities and Exchange Commission, including reports on Forms 10-K, 10-Q, and 8-K. We undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.
Statements regarding the following subjects, among others, are forward-looking by their nature: statements we make regarding Redwood’s business strategy and strategic focus, statements related to our financial outlook and expectations for 2018, statements regarding our available capital and sourcing additional capital both internally and from the capital markets, and other statements regarding pending business activities and expectations and estimates relating to our business and financial results. Additional detail regarding the forward-looking statements in this Redwood Review and the important factors that may affect our actual results in 2018 are described in the Appendix of this Redwood Review under the heading “Forward-Looking Statements.”



 
THE REDWOOD REVIEW I 2ND QUARTER 2018
2

 
I N T R O D U C T I O N

Note to Readers:

We file annual reports (on Form 10-K) and quarterly reports (on Form 10-Q) with the Securities and Exchange Commission. These filings and our earnings press releases provide information about Redwood and our financial results in accordance with generally accepted accounting principles (GAAP). These documents, as well as information about our business and a glossary of terms we use in this and other publications, are available through our website, www.redwoodtrust.com. We encourage you to review these documents.
References herein to “Redwood,” the “company,” “we,” “us,” and “our” include Redwood Trust, Inc. and its consolidated subsidiaries. Note that because we round numbers in the tables to millions, except per share amounts, some numbers may not foot due to rounding. References to the “second quarter” refer to the quarter ended June 30, 2018, and references to the “first quarter” refer to the quarter ended March 31, 2018, unless otherwise specified.
We hope you find this Review helpful to your understanding of our business. We thank you for your input and suggestions, which have resulted in our changing the form and content of The Redwood Review over time.
 
Selected Financial Highlights
 
 
Quarter:Year
 
GAAP
Income
per Share
 
REIT Taxable
Income per
Share (1)
 
Annualized
GAAP Return
on Equity
 
GAAP Book
Value per
Share
 
Dividends
per Share
 
Economic Return on Book Value (2)
 
Q218
 
$0.38
 
$0.35
 
11%
 
$16.23
 
$0.30
 
2.5%
 
Q118
 
$0.50
 
$0.44
 
15%
 
$16.12
 
$0.28
 
3.6%
 
Q417
 
$0.35
 
$0.42
 
10%
 
$15.83
 
$0.28
 
2.8%
 
Q317
 
$0.41
 
$0.26
 
12%
 
$15.67
 
$0.28
 
4.3%
 
Q217
 
$0.43
 
$0.25
 
12%
 
$15.29
 
$0.28
 
2.9%
 
Q117
 
$0.43
 
$0.22
 
13%
 
$15.13
 
$0.28
 
3.0%
 
Q416
 
$0.31
 
$0.34
 
9%
 
$14.96
 
$0.28
 
3.4%
 
Q316
 
$0.58
 
$0.34
 
19%
 
$14.74
 
$0.28
 
5.8%
 
Q216
 
$0.48
 
$0.36
 
15%
 
$14.20
 
$0.28
 
2.2%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
REIT taxable income per share for 2017 and 2018 are estimates until we file our tax returns.
(2)
Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
3

 
S H A R E H O L D E R L E T T E R

Dear Fellow Shareholders:
This year has marked the start of the next new era for Redwood Trust, an era we plan to signify through our commitment to profitable growth. As always, there will be plenty of ink dedicated to our metrics when we publish the second quarter Redwood Review. However, with our recent leadership transition now complete, we thought we would focus in this letter on our vision for the future, and offer insight into how we’ll lead Redwood during this next chapter.
To understand where we should be going, we first had to reassess who we are and where we have been. With 24 years of organizational history, we had much to consider. This assessment was a major aspect of our strategic planning sessions last December. Together with our Board, we reaffirmed our highest competencies and competitive strengths, and ultimately defined how we can maximize the value we deliver to our business partners while building shareholder wealth.
So, who are we? Above all else, we are a specialty finance company that plays a central role in the inner workings of housing finance. This is a rare combination at the heart of our franchise value and corporate vision. It gives us a unique strategic relevance to the market and it has the capacity to propel our growth initiatives and facilitate our continued role as a premier housing credit investor.
Through our mortgage loan acquisition and structuring platform, our business helps facilitate the ultimate financing of homeowners through the capital markets. We work as a direct partner to mortgage lenders throughout the country, rather than just as an end-investor. Through our conduit operations, our platform has both the ability to generate repeatable, fee-based revenues and create long-term, differentiated investments. Our brand value is heavily derived through the mortgage products and services we provide to the market, so we don’t skimp on infrastructure to compete on cost. Our platform does, however, have the capacity to create significant operating scale as we grow. The quality of our people and processes remain the most critical factor to our success. Our people drive the business partnerships and risk-minded approach that have made us one of the industry’s longest standing firms.
Although we are organized as a real estate investment trust (REIT) for federal income tax purposes and comply with the relevant rules, that structure does not define us. Redwood’s likeness to other mortgage REITs has decreased across a number of key areas such as our leverage profile, revenue mix, and risk metrics (including exposure to interest rates). Our formula for profitability is straightforward: sound credit decisions; crisp execution; and rational, risk-based pricing. Our earnings are not driven by the shape of the yield curve. How we further differentiate our operating platform and revenue streams is a topic we’ll continue to evaluate as our vision takes shape.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
4

 
S H A R E H O L D E R L E T T E R

We have an exceptional track record in housing credit – both residential and multifamily. We are an expert at product structuring and customization. Our securitization franchise is one of the most well-established in the industry. We have a strong balance-sheet and access to various sources of capital (as evidenced by our recent convertible bond and common equity raises), often at a significantly lower cost than what’s available to originators who supply us with loans. We excel at speed and reliable execution, in marked contrast to less nimble and much larger banks and other providers who compete primarily on price.
Our business strategy going forward is squarely focused on areas in which these strengths are expected to lead to long-term, sustainable earnings growth for Redwood. Specifically, we plan to focus our operations on areas that achieve the following:
Our capital is value-added to the marketplace
There is a long runway of durable revenues available to us
Our core strengths are a competitive advantage
We can scale profitably and realize significant operating efficiencies
We feel the risks associated with investing can be prudently managed    
Our strategic plan is responsive to trends we view as secular rather than transitory. These trends reflect constraints on the supply of homes and attendant changes in demand in household formation (i.e., renting versus owning). Our future success will depend on our ability to accurately predict where capital will flow in response to these changes, along with the understanding that borrowers ultimately migrate to superior service. This all requires nimble and thorough risk oversight, a demonstrated competency of our firm.
Fortunately, our efforts toward building a differentiated and sustainable path for our business are well underway. Redwood Choice – our expanded-prime channel – now represents almost one-third of our mortgage banking volumes. Our total volumes, meanwhile, remain on track to increase meaningfully from last year amidst declining industry originations. Our investment portfolio continues to deepen its purchasing power by diversifying into other housing investments, such as Freddie Mac-sponsored multifamily bonds. Most recently, our new partnership with 5 Arches gives us access to an attractive pipeline of single-family rental and other “business-purpose” mortgage loans and a growing stream of asset management revenues.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
5

 
S H A R E H O L D E R L E T T E R

Effective implementation of our vision requires quantitative benchmarks, and we have laid out several key targets. Our goal is for annual mortgage banking volumes and total shareholder capital deployed five years from now to be at least two to three times what they are today. We aim to diversify our sources of revenue to achieve a more balanced mix of fee-based activities and income from portfolio investing. A prudent growth trajectory to these benchmarks should drive our expense ratios meaningfully lower. As an internally-managed company, our investors benefit directly from these efficiencies. If we are successful, we believe our valuation will reflect the quality and repeatability of these earnings, not simply the latest move in our net worth. And our EPS, after the realization of significant untapped operating leverage, should grow significantly with the potential to command a multiple commensurate with the highest-quality firms in the financial services industry.
We have a long history of success at Redwood and, as we begin a new chapter, we are committed to achieving much more. We have a clear plan in place to expand our strategic footprint while staying true to our core principles. Through a well-reasoned commitment to profitable growth, we plan to continue optimizing our role in the housing finance market. We believe the fruits of our labor will be powerful and measurable: diversified and predictable earnings that, complemented by scale, will drive attractive shareholder returns.
We appreciate your support and confidence in us.
Sincerely,


394548438_q218ceosignature.jpg
 
394548438_q218presidentsignature.jpg
Christopher J. Abate
 
Dashiell I. Robinson
Chief Executive Officer
 
President





 
THE REDWOOD REVIEW I 2ND QUARTER 2018
6

 
Q U A R T E R L Y O V E R V I E W

Second Quarter Highlights
Ñ
Our GAAP earnings were $0.38 per share for the second quarter of 2018, as compared with $0.50 per share for the first quarter of 2018. This change was driven primarily by mortgage banking margins that were within our long-term expected range, but lower relative to the first quarter, as well as fewer realized gains on available-for-sale securities relative to the first quarter.
Ñ
Our non-GAAP core earnings(1) were $0.41 per share for the second quarter of 2018, as compared with $0.60 per share for the first quarter of 2018. Core earnings exceeded GAAP earnings in the second quarter primarily due to gains realized from sales of trading securities during the quarter.
Ñ
Our GAAP book value was $16.23 per share at June 30, 2018, an increase of $0.11 per share from the first quarter, and represented an economic return(2) of 2.5% for the quarter. This increase was driven primarily by our quarterly earnings exceeding our dividend and an increase in the value of our long-term debt hedge.
Ñ
We deployed $186 million of capital in the second quarter of 2018 toward new investments, including $66 million in Sequoia and third-party RMBS, $65 million in Agency residential CRT securities, and $6 million in Agency multifamily securities. Additionally, we deployed $50 million into new initiatives, including $40 million in customized financing for our jumbo loan sellers and $10 million to acquire a minority interest in business-purpose mortgage lender 5 Arches, LLC.
Ñ
We sold $108 million of securities during the second quarter of 2018, capturing $12 million of previously unrealized gains ($5 million of realized gains from AFS securities and $7 million of non-GAAP core fair value gains from trading securities) and generating $91 million of capital for reinvestment after the repayment of associated debt.
Ñ
We purchased $2.0 billion of residential jumbo loans during the second quarter of 2018. At June 30, 2018, our pipeline of jumbo residential loans identified for purchase was $1.3 billion.
Ñ
Residential loan sales totaled $1.9 billion during the second quarter of 2018 and included $1.7 billion of loans that were securitized and $0.3 billion of whole loan sales to third parties.
Ñ
We issued $200 million of six-year, 5.625% convertible debt during the second quarter of 2018.
Ñ
Our recourse debt to equity leverage ratio was 3.4x at the end of the second quarter of 2018.
Ñ
In late July, we raised $117 million of equity capital in our first follow-on offering since 2009.
_____________________
(1) For details on GAAP and non-GAAP core earnings, see the GAAP Net Income and Reconciliation to Non-GAAP Core Earnings section that follows on page 8.
(2) Economic return on book value is based on the periodic change in GAAP book value per common share plus dividends declared per common share during the period.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
7

 
Q U A R T E R L Y O V E R V I E W

GAAP Net Income and Reconciliation to Non-GAAP Core Earnings
Below we present GAAP net income and a reconciliation to non-GAAP core earnings for the second and first quarters of 2018. Further information about Redwood's core earnings measure and core earnings adjustments are included in the Core Earnings Definition section of the Appendix.

 
GAAP Net Income and Reconciliation to Non-GAAP Core Earnings
($ in millions, except per share data)
 
Three Months Ended
 
 
6/30/2018
 
3/31/2018
 
 
 
 
 
 
Interest income
$
83

 
$
77

 
Interest expense
(48
)
 
(42
)
 
Net interest income
35

 
35

 
 
 
 
 
 
Non-interest income
 
 
 
 
Mortgage banking activities, net
11

 
27

 
Investment fair value changes, net
1

 
2

 
Other income, net
3

 
2

 
Realized gains, net
5

 
9

 
Total non-interest income, net
20

 
40

 
 
 
 
 
 
Operating expenses
(19
)
 
(23
)
 
Provision for income taxes
(3
)
 
(5
)
 
 
 
 
 
 
GAAP net income
$
33

 
$
47

 
 
 
 
 
 
Core earnings adjustments
 
 
 
 
Eliminate mark-to-market changes on long-term investments and associated derivatives
(3
)
 
(7
)
 
Include cumulative gain (loss) on long-term investments sold, net
7

 
18

 
Income tax adjustments associated with core earnings adjustments

 

 
Non-GAAP core earnings
$
36

 
$
58

 
 
 
 
 
 
GAAP net income per diluted common share
$
0.38

 
$
0.50

 
Non-GAAP core earnings per diluted common share (1)
$
0.41

 
$
0.60

 
(1)
Consistent with the calculation of net income per diluted common share for GAAP purposes, non-GAAP core earnings per diluted common share is calculated following the "two-class" method. Additional information on the calculation of core earnings using the "two-class" method can be found in Table 2 in the Financial Tables section of this Redwood Review.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
8

 
Q U A R T E R L Y O V E R V I E W

Analysis of Earnings
Ñ
Net interest income was $35 million for the second quarter of 2018, consistent with the first quarter of 2018. The benefit from higher average returns resulting from portfolio optimization was offset by higher interest expense on our floating rate debt during the second quarter. We note that the benefit from interest rate hedges associated with our portfolio investments is reported in our Investment fair value changes line item and is discussed further below and in the Segment Results section that follows.
Ñ
Mortgage banking activities, net, decreased to $11 million for the second quarter of 2018, from $27 million for the first quarter of 2018, driven primarily by gross margins that were within our long-term expected range, but lower relative to the first quarter.
Ñ
Investment fair value changes, net, on a GAAP basis were $1 million for the second quarter of 2018, as hedge costs and the effect of principal paydowns on our investments were more than offset by the net benefit from spread tightening on our securities portfolio. On a non-GAAP core earnings basis, after eliminating certain mark-to-market changes on long-term investments (and associated derivatives), investment fair value changes, net, were negative $2 million for the second quarter of 2018, as compared with negative $6 million for the first quarter of 2018. The decline in this value is a result of the benefit from lower hedge interest expense in the second quarter of 2018, which partially offsets the increase in interest expense included in net interest income above.
Ñ
On a GAAP basis, we realized gains of $5 million during the second quarter of 2018, which were primarily related to the sale of $41 million of available-for-sale securities, as compared with realized gains of $9 million during the first quarter of 2018. On a non-GAAP core earnings basis, realized gains also include the cumulative net gains or losses on trading securities sold, and decreased to $12 million for the second quarter from the sale of $108 million of securities, as compared with $28 million for the first quarter.
Ñ
Operating expenses were $19 million for the second quarter of 2018, as compared with $23 million for the first quarter of 2018. The decline in operating expenses was primarily the result of lower variable compensation expense in the second quarter commensurate with lower GAAP earnings during the quarter.
Ñ
We recorded a tax provision of $3 million during the second quarter of 2018, as compared with a tax provision of $5 million for the first quarter of 2018. This decrease was primarily due to lower mortgage banking income relative to the first quarter. A reconciliation of GAAP and taxable income is set forth in Table 5 in the Financial Tables section of this Redwood Review.
Ñ
Additional details on our earnings are included in the Segment Results section that follows.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
9

 
Q U A R T E R L Y O V E R V I E W

Segment Results
We report on our business using two distinct segments: Investment Portfolio and Residential Mortgage Banking. The following table presents the results from each of these segments reconciled to our GAAP net income for the second and first quarters of 2018.
 
Segment Results Summary (1)
($ in millions)
 
Three Months Ended
 
 
6/30/2018
 
3/31/2018
 
 
 
 
 
 
Investment portfolio
 
 
 
 
Net interest income
$
38

 
$
39

 
Investment fair value changes, net
2

 
2

 
Other income, net
3

 
2

 
Realized gains, net
5

 
9

 
Operating expenses
(2
)
 
(2
)
 
Provision for income taxes
(1
)
 
(1
)
 
Segment contribution
$
44

 
$
49

 
 
 
 
 
 
Residential mortgage banking
 
 
 
 
Net interest income
$
5

 
$
7

 
Mortgage banking activities, net
11

 
27

 
Operating expenses
(6
)
 
(9
)
 
Provision for income taxes
(1
)
 
(4
)
 
Segment contribution
$
9

 
$
21

 
 


 
 
 
Corporate/Other
(21
)
 
(23
)
 
 
 
 
 
 
Net income
$
33

 
$
47

 
(1)
See Table 3 in the Financial Tables section of this Redwood Review for a more comprehensive presentation of our segment results.
Investment Portfolio
Ñ
Both segment contribution and non-GAAP core segment contribution (presented in the following table) from our investment portfolio declined during the second quarter, as we realized fewer gains from the sale of AFS securities, which reduced segment contribution, and also realized fewer gains from the sale of trading securities, reducing non-GAAP core segment contribution.
Ñ
Credit fundamentals in our investment portfolio remain strong, benefiting from continued housing price growth and improvements in the general economy.


 
THE REDWOOD REVIEW I 2ND QUARTER 2018
10

 
Q U A R T E R L Y O V E R V I E W

The following table presents segment contribution of our investment portfolio by asset type for the second and first quarters of 2018.
 
Segment Contribution of Investment Portfolio by Type
($ in millions)
 
Three Months Ended
 
 
6/30/2018
 
 
3/31/2018
 
 
Loans
 
Securities (2)
 
Total
 
 
Loans
 
Securities (2)
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total net interest income
$
14

 
$
24

 
$
38

 
 
$
16

 
$
23

 
$
39

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment fair value changes, net
 
 
 
 
 
 
 
 
 
 
 
 
 
Change in basis and hedge expense
1

 
(3
)
 
(2
)
 
 
(3
)
 
(3
)
 
(6
)
 
Other valuation changes
(2
)
 
6

 
4

 
 

 
7

 
7

 
Other income, net

 
3

 
3

 
 

 
2

 
2

 
Realized gains, net

 
5

 
5

 
 

 
9

 
9

 
Total non-interest income, net
(1
)
 
11

 
10

 
 
(2
)
 
15

 
13

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Direct operating expenses
(1
)
 
(1
)
 
(2
)
 
 

 
(2
)
 
(2
)
 
Provision for income taxes

 
(1
)
 
(1
)
 
 

 
(1
)
 
(1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Segment contribution
$
12

 
$
32

 
$
44

 
 
$
13

 
$
36

 
$
49

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Core Earnings adjustments (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
Eliminate mark-to-market changes on long-term investments and associated derivatives
2

 
(6
)
 
(4
)
 
 

 
(7
)
 
(7
)
 
Include cumulative gain (loss) on long-term investments sold, net

 
7

 
7

 
 

 
18

 
18

 
Income taxes associated with core earnings adjustments

 

 

 
 

 

 

 
Total core earnings adjustments
2

 
1

 
3

 
 

 
11

 
11

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-GAAP core segment contribution (1)
$
14

 
$
33

 
$
47

 
 
$
13

 
$
47

 
$
60

 
(1)
Consistent with management's definition of core earnings set forth on page 34, non-GAAP core segment contribution reflects GAAP segment contribution adjusted to reflect the portion of core earnings adjustments allocable to this segment.
(2)
Includes results from securities retained from our Sequoia Choice securitizations, which we consolidated for GAAP purposes, as well as other investments.
Ñ
While net interest income from residential loans declined in the second quarter of 2018 due to rising benchmark interest rates, the net interest expense from the hedges associated with these loans also decreased, effectively offsetting this decline.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
11

 
Q U A R T E R L Y O V E R V I E W

Residential Mortgage Banking
Ñ
Segment contribution from residential mortgage banking declined during the second quarter of 2018 as a result of gross margins that were lower relative to the first quarter of 2018 but within our long-term expected range of 75 to 100 basis points. We define gross margins for this segment as net interest income plus mortgage banking activities, net, divided by loan purchase commitments (LPCs).
Ñ
LPCs, adjusted for fallout expectations, were $2.0 billion for the second quarter of 2018, as compared with $1.7 billion for the first quarter of 2018. Choice loans comprised 33% of total LPCs in the second quarter, and increased 35% from the prior quarter and 119% from the same quarter last year.
Ñ
Loan purchase volumes in the second quarter of 2018, as presented below, increased 8% from the prior quarter and 60% from the same quarter last year.
394548438_purchasevolumea02.jpg
Ñ
During the second quarter of 2018, we completed three traditional Select securitizations and one Choice securitization (our fourth since inception of our Choice program). Loan sales in the second quarter of 2018 decreased to $1.9 billion from $2.0 billion in the first quarter (inclusive of securitized loans).
Ñ
At June 30, 2018, we had 470 loan sellers, which included 181 jumbo sellers and 289 MPF Direct sellers from various FHLB districts. Currently, 85% of our jumbo sellers have rolled out the Choice program and 95% of these sellers have begun locking Choice loans.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
12

 
Q U A R T E R L Y O V E R V I E W

GAAP Book Value
The following table sets forth the changes in Redwood’s GAAP book value per share for the second and first quarters of 2018.
 
Changes in GAAP Book Value per Share
($ in per share)
 
Three Months Ended
 
 
6/30/2018
 
3/31/2018
 
 
 
 
 
 
Beginning book value per share
$
16.12

 
$
15.83

 
Earnings
0.38

 
0.50

 
Changes in unrealized gains on securities, net, from:
 
 
 
 
Realized gains recognized in earnings
(0.05
)
 
(0.09
)
 
Amortization income recognized in earnings
(0.04
)
 
(0.04
)
 
Mark-to-market adjustments, net
0.01

 

 
Total change in unrealized gains on securities, net
(0.08
)
 
(0.13
)
 
Dividends
(0.30
)
 
(0.28
)
 
Share repurchases

 
0.01

 
Equity compensation, net
0.03

 
0.03

 
Changes in unrealized losses on derivatives hedging long-term debt
0.05

 
0.11

 
Other, net
0.03

 
0.05

 
 
 
 
 
 
Ending book value per share
$
16.23

 
$
16.12

 

Ñ
Our GAAP book value per share increased $0.11 per share to $16.23 per share during the second quarter of 2018. This increase was driven primarily by earnings exceeding the dividend and an increase in value of derivatives hedging our long-term debt.
Ñ
Unrealized gains on our available-for-sale securities decreased $0.08 per share during the second quarter of 2018. This decrease primarily resulted from $0.05 per share of previously unrealized net gains that were realized as income from the sale of securities, as well as $0.04 per share of discount accretion income recognized in earnings from the appreciation in the amortized cost basis of our available-for-sale securities.
Ñ
Higher benchmark interest rates during the second quarter of 2018 resulted in a $0.05 per share increase to book value due to a decrease in unrealized losses on the derivatives hedging a portion of our long-term debt. At June 30, 2018, the cumulative unrealized loss on these derivatives, which is included in our GAAP book value per share, was $0.41 per share.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
13

 
Q U A R T E R L Y O V E R V I E W

Capital Allocations
We use a combination of equity and corporate debt (which we collectively refer to as “capital”) to fund our business.
Capital Allocation: By Source and By Business Use
(as of June 30, 2018)
394548438_capallocationa04.jpg
Ñ
Our total capital of $2.0 billion at June 30, 2018 included $1.2 billion of equity capital and $0.8 billion of the total $2.8 billion of long-term debt on our consolidated balance sheet. This portion of debt includes $201 million of exchangeable debt due in 2019, $245 million of convertible debt due in 2023, $200 million of convertible debt due in 2024, and $140 million of trust-preferred securities due in 2037. This portion of debt has a weighted average cost of approximately 6.1%.
Ñ
We also utilize various forms of short-term and long-term collateralized debt to finance certain investments and to warehouse our inventory of certain residential loans held-for-sale. We do not consider this collateralized debt as "capital" and, therefore, exclude it from our capital allocation analysis.
Ñ
The Balance Sheet Analysis portion of the Financial Insights section that follows describes our long-term and short-term borrowings in further detail.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
14

 
Q U A R T E R L Y O V E R V I E W

 
Capital Allocation Detail
By Investment Type
June 30, 2018
($ in millions)
 
GAAP Fair Value
 
Collateralized Debt
 
Allocated Capital
 
% of Total Capital
 
 
 
 
 
 
 
 
 
 
Residential loans (1)
$
2,356

 
$
(2,000
)
 
$
356

 
18%
 
 
 
 
 
 
 
 
 
 
Securities portfolio
 
 
 
 
 
 
 
 
Third party residential securities
763

 
(242
)
 
521

 
26%
 
Sequoia residential securities (2)
426

 
(153
)
 
274

 
14%
 
Multifamily securities
399

 
(313
)
 
86

 
4%
 
Total securities portfolio
1,588

 
(707
)
 
881

 
44%
 
 
 
 
 
 
 
 
 
 
Other investments
146

 

 
146

 
7%
 
Other assets/(liabilities)
154

 
(56
)
 
98

 
5%
 
Cash and liquidity capital
 
 
 
 
308

 
N/A
 
 
 
 
 
 
 
 
 
 
Total Investments
$
4,244

 
$
(2,763
)
 
$
1,789

 
90%
 
 
 
 
 
 
 
 
 
 
Residential mortgage banking
 
 
 
 
$
210

 
10%
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
$
1,999

 
100%
 
(1)
Includes $43 million of FHLB stock.
(2)
In addition to our $1.5 billion of securities on our GAAP balance sheet, securities presented above also include $134 million of securities retained from our Sequoia Choice securitizations. For GAAP purposes, we consolidate these Sequoia Choice securitizations.
Ñ
During the second quarter of 2018, we continued to optimize our portfolio by selling lower-yielding securities and redeploying proceeds into higher-yielding alternatives, including into new initiatives. (See Table 7 in the Financial Tables section for additional detail on asset activity and balances.)
Ñ
As of June 30, 2018, our cash and liquidity capital included $200 million of available capital. 
Ñ
Additionally, in July of 2018, we issued $117 million of common equity, which will provide additional available capital for us going forward.


 
THE REDWOOD REVIEW I 2ND QUARTER 2018
15

 
Q U A R T E R L Y O V E R V I E W

2018 Financial Outlook(1)  
Our 2018 results are on track to exceed our expected dividend payments of $1.18 per share. Below we provide an update on the key targeted 2018 operating metrics we provided in our fourth quarter 2017 Redwood Review:
Mortgage Banking
Our mortgage banking business had solid performance in the first half of 2018. Gross margins were above our long-term expected range of 75 to 100 basis points and annualized returns on allocated capital(2) were also above our target range of 10 to 20%. For the full year of 2018 we continue to expect margins and returns on allocated capital to be within our expected ranges. Our year-to-date purchase volume of $3.75 billion (including $1.2 billion of Redwood Choice loans) puts us on track to meet our full-year expectations of purchasing $7 to $8 billion of jumbo loans and doubling our Choice purchase volume from 2017.
Investment Portfolio
Our investment portfolio performed well in the first half of 2018, generating annualized returns on allocated capital(3) in line with our expectations of 9% to 11%. For the full year of 2018, we continue to expect portfolio returns to be in line with our 2018 return expectations. This assumes additional realized gains from portfolio optimization and a benefit from higher yields as we redeploy capital into new opportunities.
Corporate
Total operating expenses were $42 million in the first half of 2018, and included $14 million of mortgage banking expenses and $4 million of portfolio expenses (each of which are included in the segment returns provided above), as well as $24 million of corporate expenses. We currently expect full-year corporate operating expenses of between $40 and $45 million, with variable compensation commensurate with company performance. We issued $200 million of convertible debt in June 2018 and $117 million of common equity in July 2018. Depending on the rate of deployment into new initiatives and other long-term investments, this capital may be modestly dilutive to our earnings in the second half of 2018.
_____________________
(1)
As with all forward-looking statements, our forward-looking statements relating to our 2018 financial outlook are subject to risks and uncertainties, including, among other things, those described in our Annual Report on Form 10-K under the caption “Risk Factors” and other risks, uncertainties, and factors that could cause actual results to differ materially from those described above and under the heading "Forward-Looking Statements" in the Appendix to this Redwood Review, including those described in the “Cautionary Statement” at the beginning of this Redwood Review. Although we may update our 2018 financial outlook subsequently in 2018, as a general matter we undertake no obligation to update or revise forward-looking statements, whether as a result of new information, future events, or otherwise.
(2)
Includes net interest income, mortgage banking activities, direct operating expenses, and taxes. Excludes corporate operating expenses. Returns are calculated based on average capital allocated during the period.
(3)
Includes net interest income, changes in fair value of the investments and their associated hedges that flow through GAAP earnings, realized gains, direct operating expenses, taxes, and other income. Excludes unrealized gains and losses on our AFS securities portfolio, and corporate operating expenses. Returns are calculated based on average capital allocated during the period.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
16

 
F I N A N C I A L I N S I G H T S

Balance Sheet Analysis
The following table presents our consolidated balance sheets at June 30, 2018 and March 31, 2018.
 
Consolidated Balance Sheets (1)
($ in millions)
 
6/30/2018
 
3/31/2018
 
 
 
 
 
 
Residential loans
$
5,491

 
$
5,146

 
Real estate securities
1,454

 
1,358

 
Cash and cash equivalents
185

 
179

 
Other assets
383

 
318

 
 
 
 
 
 
Total assets
$
7,513

 
$
7,000

 
 
 
 
 
 
Short-term debt
 
 
 
 
Mortgage loan warehouse debt
$
719

 
$
662

 
Security repurchase facilities
707

 
592

 
Convertible notes, net (2)

 
250

 
Other liabilities
157

 
158

 
Asset-backed securities issued
1,930

 
1,542

 
Long-term debt, net
2,770

 
2,576

 
Total liabilities
6,284

 
5,780

 
 
 
 
 
 
Stockholders’ equity
1,229

 
1,220

 
 
 
 
 
 
Total liabilities and equity
$
7,513

 
$
7,000

 
(1)
Our consolidated balance sheets include assets of consolidated variable interest entities (“VIEs”) that can only be used to settle obligations of these VIEs and liabilities of consolidated VIEs for which creditors do not have recourse to the primary beneficiary (Redwood Trust, Inc.). At June 30, 2018 and March 31, 2018, assets of consolidated VIEs totaled $2.1 billion and $1.6 billion, respectively, and liabilities of consolidated VIEs totaled $1.9 billion and $1.5 billion, respectively. See Table 8 in the Financial Tables section of this Redwood Review for additional detail on consolidated VIEs.
(2)
Certain of our convertible notes were classified as Short-term debt as the maturity of the notes was less than one year as of March 31, 2018.










 
THE REDWOOD REVIEW I 2ND QUARTER 2018
17

 
F I N A N C I A L I N S I G H T S

Recourse Financing
We finance our business with a diversified mix of long-term and short-term recourse debt. The following charts present the composition of our recourse debt and its characteristics at the end of the second quarter:
394548438_recoursefinancinga01.jpg
 
Borrowing Type
Average Cost of Funds
Average Remaining Term (yrs.)
 
 
 
FHLBC Borrowings
2.0%
7
Unsecured Corporate Debt
6.1%
7
Mortgage Warehouse
3.6%
<1
Securities Repurchase
3.2%
<1
 
 
 
Weighted Average Cost of Funds
3.2%
 
 
 
 


Ñ
Our long-term unsecured corporate debt is comprised of $200 million of 5.625% convertible notes due in 2024, $245 million of 4.75% convertible notes due in 2023, $201 million of 5.625% exchangeable notes due in 2019, and $140 million of trust-preferred securities due in 2037 (that we hedge to yield approximately 6.8%).
Ñ
Our FHLBC borrowings and securities repurchase debt are used to finance our whole loan and securities investments, respectively, and we utilize mortgage warehouse facilities to finance our mortgage banking activities. These are discussed in further detail in the following sections.
Ñ
Our recourse debt to equity leverage ratio was 3.4x at the end of the second quarter of 2018.
Ñ
In addition to our recourse financing, we have ABS debt issued by securitization entities that we consolidate that is non-recourse to us.

 
THE REDWOOD REVIEW I 2ND QUARTER 2018
18

 
F I N A N C I A L I N S I G H T S

Residential Loan Investments
At June 30, 2018, we had $2.3 billion of jumbo residential loans held for investment. The following table presents the fair value of our residential loan investments at June 30, 2018.
 
Residential Loans by Product Type
June 30, 2018
($ in millions)
Product Type
Total
 
Weighted Average Coupon
 
 
 
 
 
 
Fixed rate
$
2,081

 
4.08
%
 
Hybrid
232

 
4.09
%
 
 
 
 
 
 
Total
$
2,313

 
4.08
%
 
Ñ
Our held-for-investment loans are prime-quality, first lien jumbo loans, most of which were originated between 2013 and 2018. At June 30, 2018, the weighted average FICO score of borrowers backing these loans was 770 (at origination) and the weighted average loan-to-value ("LTV") ratio of these loans was 66% (at origination). At June 30, 2018, 0.04% of these loans (by unpaid principal balance) were more than 90 days delinquent.
Ñ
We finance our residential loan investments with $2.0 billion of FHLB debt through our FHLB-member subsidiary. The interest cost for these borrowings resets every 13 weeks, and we seek to effectively fix the interest cost of this debt over its weighted average maturity by using a combination of swaps, TBAs, and other derivative instruments.
Ñ
In connection with these borrowings, our FHLB-member subsidiary is required to hold $43 million of FHLB stock.


 
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Securities Portfolio
At June 30, 2018, we had $1.6 billion invested in real estate securities. We categorize these securities by (i) whether they were issued through our Sequoia platform, by an Agency in a CRT, or by third parties, and (ii) by priority of cash flow (senior, mezzanine, and subordinate). The following table presents the fair value of our real estate securities at June 30, 2018.
 
Securities Portfolio - By Source and Security Type
June 30, 2018
($ in millions)
 
Interest-Only Securities
 
Senior (1)
 
Mezzanine
 
Subordinate
 
Total
 
% of Total Securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sequoia (2)
$
73

 
$

 
$
189

 
$
163

 
$
426

 
27
%
 
Third Party New Issue (3)
40

 
49

 
138

 
129

 
356

 
22
%
 
Third Party Legacy (3)
2

 
147

 

 
18

 
167

 
11
%
 
Agency CRT (4)

 

 

 
240

 
240

 
15
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total residential securities
$
115

 
$
196

 
$
327

 
$
550

 
$
1,189

 
75
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily securities (4)

 

 
399

 

 
399

 
25
%
 
Total securities portfolio
$
115

 
$
196

 
$
726

 
$
550

 
$
1,588

 
100
%
 
(1)
Includes $34 million of re-REMIC securities at June 30, 2018.
(2)
Presents securities retained from our Sequoia securitizations that were issued from 2012 through 2018. These securities included $14 million of interest-only securities, $88 million of mezzanine securities, and $32 million of subordinate securities retained from our Sequoia Choice securitizations, which were consolidated for GAAP purposes.
(3)
Presents RMBS issued by third parties after 2012 as New Issue and prior to 2008 as Legacy.
(4)
Agency CRT and Multifamily securities were issued after 2012.
At June 30, 2018, our securities consisted of fixed-rate assets (65%), adjustable-rate assets (28%), hybrid assets that reset within the next year (6%), and hybrid assets that reset between 12 and 36 months (1%). For the portions of our securities portfolio that are sensitive to changes in interest rates, we seek to minimize this interest rate risk by using various derivative instruments.
We finance our holdings of real estate securities with a combination of capital and collateralized debt in the form of repurchase (or “repo”) financing. At June 30, 2018, we had short-term debt incurred through repurchase facilities of $707 million, which was secured by $846 million of real estate securities. The remaining $742 million of securities were financed with capital.

 
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The following table presents the fair value of our real estate securities that are financed with repurchase debt, at June 30, 2018.
 
Real Estate Securities Financed with Repurchase Debt
June 30, 2018
($ in millions, except weighted average price)
 
Real Estate Securities
 
Repurchase Debt
 
Allocated Capital
 
Weighted Average Price (1)
 
Financing Haircut (2)
 
 
 
 
 
 
 
 
 
 
 
 
Residential securities
 
 
 
 
 
 
 
 
 
 
Senior
$
161

 
$
(142
)
 
$
19

 
$
98

 
12
%
 
Mezzanine
293

 
(252
)
 
41

 
$
96

 
14
%
 
Total residential securities
454

 
(395
)
 
59

 
 
 
 
 
Multifamily securities
392

 
(313
)
 
79

 
$
95

 
20
%
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
846

 
$
(707
)
 
$
138

 
$
96

 
16
%
 
(1)
GAAP fair value per $100 of principal.
(2)
Allocated capital divided by GAAP fair value.
Ñ
In addition to the allocated capital listed in the table above that directly supports our repurchase facilities (i.e., “the haircut”), we continue to hold a designated amount of supplemental risk capital available for potential margin calls or future obligations relating to these facilities.
Ñ
At June 30, 2018, we had securities repurchase facilities with seven different counterparties.
Ñ
Additional information on the residential securities we own is set forth in Table 7 in the Financial Tables section of this Redwood Review.


 
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Residential Loans Held-for-Sale
Ñ
At June 30, 2018, we had $1.1 billion of residential mortgages held-for-sale financed with $719 million of warehouse debt.
Ñ
Our warehouse capacity at June 30, 2018 totaled $1.8 billion across six separate counterparties.
Ñ
The $1.1 billion of residential loans held-for-sale at June 30, 2018 included $681 million, or 62%, of Select loans, and $424 million, or 38%, of expanded-prime Choice loans.
Ñ
At June 30, 2018, our pipeline of jumbo residential loans identified for purchase was $1.3 billion.
Ñ
We seek to minimize the exposure we have to interest rates on our loan pipeline (for loans both on balance sheet and identified for purchase) by using a combination of TBAs, interest rate swaps, and other derivative instruments.



 
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  G L O S S A R Y

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Table 1: GAAP Earnings (in thousands, except per share data)